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Due to a less than expected growth, Chipotle (CMG) dropped from $440 to $300 earlier this year. A further decline was aided by David Einhorn's thesis that Taco Bell's Cantina Bell menu would drive customers away from CMG. CMG was also expected to experience higher expenses due to higher costs of meat and grain, along with employee healthcare spending, according to Einhorn. In our last article, we had recommended a long position, but had warned that the high P/E multiple of 28x prices in high growth, so investors should be mindful of any further slowdown. The large drop in price can be attributed to slower than expected growth. The valuations seem more reasonable now for a growing company. We recommend buying CMG.

Q3 results:

Revenue increased by a solid 18.4% and almost met analyst expectations, although the growth rate was below the 24% increase experienced in Q32011. Comparable restaurant sales were up 4.8% as compared to 11.3% in 2011 and 8% in Q22012. Operating margins for restaurants have improved by 0.7 percentage points. Net income grew by 19.6% as compared to 25.3% in Q32011. EPS of $2.27 were 19.5% more than last year, but missed analyst expectations of $2.3 by 3 cents per share.

The growth in revenues was driven by new restaurant openings and higher traffic at existing restaurants as compared to menu price increases, according to the company. The company expects to open 155-165 restaurants in 2012 and 165-180 in 2013. Comparable store sales are expected to be mid-single digit in 2012 and flat-to-low single in 2013, showing that the growth would be mainly coming from new restaurants. The company also says that the threat from Cantina Bell is not as much, as CMG's customers are loyal and know the difference.

The company increased its share repurchase authorization by $100 million, which now stands at a total of $134.7 million. The company's CEO hinted at "opportunistic" buy backs of shares recently.

Valuation:

The company now trades at a forward P/E of 23x, which we think is reasonable for a company that has strong fundamentals, improving margins, and is still growing. Every company goes through a slow down after an initial hyper growth stage. The PEG ratio of 1.26 as compared to McDonald's (MCD) 1.87 and YUM Brands' (YUM) 1.61 shows that the stock is trading lower than its growth expectations. CMG's next 5-year growth rate is 21% as compared to MCD's 8% and YUM's 13%. MCD and YUM, however, pay dividends, while CMG does not.

Below are CMG's valuations based on a forward P/E of 23x and a growth rate of 21% for 2014 EPS estimates.


To reiterate, we recommend buying CMG as the slowdown in growth is priced in.

Source: Buy Chipotle: Slowdown In Growth Is Priced In